Question by ckinc: Small business taxes on multi-member LLC?
Lets say you are one partner out of a five member family business formed in an LLC. No one really put any money into it, you just started working as subcontractors for bigger businesses (construction business). So, all of your books are in order, and you take it all into to a CPA. Your CPA tells you that your books aren’t in proper order and small things that were paid for by one member such as state filing fees (only $ 125) and business cards ($ 15-$ 30) must be accounted for as capital for that member. Your idea was to show no initial investment and just claim those costs as a business expense on your personal taxes. Why is the CPA correct? How does that benefit you? And as a first time small business bookkeeper, how to show capital investment for an individual partner on Microsoft Accounting?
Best answer:
Answer by Bostonian In MO
The CPA is correct because he is following the GAAP.
As to how to handle it in your software, if the CPA can’t advise you (most can figure it out pretty quickly) he can hook you up with a consultant who can.
Know better? Leave your own answer in the comments!
Here is why your CPA is correct:
1. Your LLC is treated as a partnership for federal income tax purposes. Treas. Reg. sec. 301.7701-3(b).
2. When a partner pays for something on behalf of the partnership, it will generally be treated as a contribution to the partnership in the amount of the payment unless, under section 707 of the Tax Code, it is treated as a transaction between the partnership and a partner “not acting in his capacity as a partner.” In this case, however, the expenses were inccurred solely for the benefit of the partnership. Even though it was your intention that all partners have a “profits only” interest in the partnership (hence no capital contributions), the fact that certain partners made effective contributions to the partnership means that the partnership is not “profits only.” This is true even if the expenses were relatively small.
3. Because what you call expenses will be treated for federal tax purposes as contributions of capital in return for partnership interests, this requires adjustment to the books of the partnership so that they accord with the rules of Treas. Reg. section 1.704-1(b)(2)(iv). Partnership books must generally be maintained in accordance with that regulation if allocations of partnership items are to be respected for tax purposes.
4. Under Treas. Reg. section 1.704-1(b)(2)(iv)(b), a partner’s capital account must be increased by the value of any property contributed by a partner to the partnership.
Your CPA is telling you the right thing: the partnership’s books were not in order, and they need adjustment to reflect the fact that certain partners now hold not only a profits interest, but a capital interest. If proper adjustments aren’t made, the entire arrangement could blow up in your face if the IRS were to audit you and the other partners. You should trust your CPA on this one.
Agree with above.
Starting a business entity, such as an LLC, without understanding the tax implications is a big mistake. They say starting a partnership is like getting married. It’s a lot easier to get into than out of.
The only way to keep those expenses out of a capital account is if the partnership agreement specifically states the partner must pay unreimbursed partnership expenses out of pocket. Then the person who paid those expenses gets to take a deduction on his or her tax return. The only way it can be in the partnership agreement is if you had a partnership agreement, which you didn’t.
Your allocation of income or loss is determined by the partners’ ownership shares reflected in the capital accounts, unless a written partnership agreement uses special allocations.
Don’t think that because you think you can operate a bookkeeping software program you’re properly recording transactions. I’ve seen lots of people who are not trained bookkeepers who buy a program and just keep entering stuff until it balances. It’s a mess about 100% of the time.
No, your books are not in order.
Learn what you’re doing or hire someone who does know. You’re headed for major headaches thinking you can do this with no knowledge or experience.